RBI optimistic on inflation... but warns of growth risks next year

The Reserve Bank on Tuesday warned of risks to growth next year due to muted private investments and weak global demand coupled with geopolitical risks, but sounded optimistic on meeting the Parliament-mandated inflation target of 2-6 per cent in the current financial year.

“The inflation outlook for 2016-17 has improved, but close vigilance is required to achieve the prospects of reaching 4 per cent. Robust consumption brightens the outlook for real gross value added growth in 2016-17, but muted private investment and weak global demand may restrain the pace of growth in 2017-18,” the central bank said in its Monetary Policy Report released today.

Despite this warning, the RBI has pegged the GVA growth of 7.6 per cent for the current fiscal and 7.9 per cent the year after.

RBI noted that daily prices of sensitive items under pulses, fruits, vegetables and cereals suggest that the seasonal surge in food prices may have peaked in July.

It expressed optimism that the trend may continue given the subdued momentum in food inflation in Q3 and the usual seasonal softening of food prices in early Q4, despite a reversal of base effect in March 2017, which improves the near-term outlook for inflation considerably.

It also expects the commodity prices to remain in check during the remaining quarters of the year.The central bank is basing its optimism on the improved household expectations on prices. In the September round of inflation expectation survey of RBI, it has found it to be 9.5 per cent in Q3 against 11.4 per cent a year ago. By contrast, producers’ inflation expectations appear to be more forward-looking.

The September round of RBI s industrial outlook survey reveals an increase in the proportion of respondents expecting higher input prices in Q3. The survey also indicates a decline in their expectations of higher selling prices.

The September round of the professional forecasters survey also indicates a greater degree of anchoring of their inflation expectations, relative to other agents, around the Reserve Bank s inflation targets. They expect inflation to ease to 4.7 per cent in Q4 of this fiscal year and to 4.4 per cent by Q2 of 2017-18.

RBI said these projections incorporate the 7th Pay Commission award relating to salaries and pensions, which will work through aggregate demand and expectation effects that will add around 10 bps to the baseline path from Q4 of 2016-17.Furthermore, the projections also factor in cost-push effect of the proposed increase in minimum wages which would add 5 bps to baseline inflation within two months of implementation.

On the impact of GST on inflation, the report notes that based on the current reckoning, the pass-through of the goods and services tax will likely commence from April 2017 and last for about 12-18 months, going by the cross-country experience.

“While the impact of GST on CPI inflation would largely depend on the standard rate decided by the GST Council, almost 50 per cent of CPI is expected to be exempt.” The Reserve Bank has warned however of risks to growth next year given the muted private investments and weak global demand coupled with geopolitical risks but is optimistic on meeting the Parliament-mandated inflation target of 2-6 per cent .

“The inflation outlook for 2016-17 has improved, but close vigilance is required to achieve the prospects of reaching 4 per cent. Robust consumption brightens the outlook for real gross value added growth in 2016-17, but muted private investment and weak global demand may restrain the pace of growth in 2017-18,” the central bank said in the Monetary Policy Report ahead of the policy review decision.